Financial services firms gird against European crisis

Rob Varnon, Connecticut Post

Rob Varnon, Staff Writer

Published 11:21 pm, Friday, December 9, 2011

Angela Merkel, Germany's chancellor, gestures during a news conference following a summit of European Leaders at the European Council headquarters in Brussels, Belgium, on Friday, Dec. 9, 2011. European leaders added 200 billion euros ($267 billion) to their crisis-fighting war-chest and tightened anti-deficit rules, seeking to lure the European Central Bank into stepping up its rescue operations. Photographer: Jock Fistick/Bloomberg *** Local Caption *** Angela Merkel
Photo: Jock Fistick, Bloomberg

The European debt contagion claimed its biggest fish in MF Global, a slew of experts say, as prominent firms fortified themselves against an overseas credit crunch that hangs over the markets heading into 2012.

MF Global filed for bankruptcy as investors and creditors got worried about the company's gambles on European debt, limiting its ability to borrow while at the same time clients were withdrawing funds from the firm, which was primarily a commodities broker.

But the positions are not unique to MF Global.

"There are hedge funds invested in (European debt)," said Josh Charney, a Morningstar alternative investment analyst. "You're not going to see much fallout from it. You won't see any huge names blowing up, but maybe some smaller firms."

Charney, like other experts, said while other investment firms hold similar investments, many have the capital and/or access to cover those positions, unlike MF Global.

MF Global's failure is a more complicated story than just a bad bet in the market, as the company faces investigations into $1.2 billion in missing client funds and questionable accounting practices.

But its failure should be a warning to investors that European debt exposure carries consequences and will remain a major concern.

No one can point to names at the moment, but expectations are that as 2012 unfolds, who properly hedged positions will become clear. And there are other ways to be exposed to European debt problems, said Edward Deak, a Fairfield University economics professor.

In Europe, at issue is whether some nations will default on their debt, creating strain on the banks that lent money to them, which in turn would damage the balance sheets of U.S. financial companies that were invested in the big European banks and the countries' bonds.

Gauging exposure can be difficult, but a review of equity holdings reported to the U.S. Securities and Exchange Commission by three prominent Connecticut hedge funds can be illustrative of exposure and some of the moves being made in the investment community of late.

SAC Capital in Stamford in November reported holdings of about $556,000 worth of stock in Spain's Banco Santander, which is down from $946,000 SAC had in the second quarter. SAC also reduced its holdings in Deutsche Bank to $459,000 from $1.38 million during the same period. It held about $1.9 million worth of shares in Bank of America in November.

A review of Greenwich-based Tudor Investment Corp.'s November holdings showed no major direct exposure to European banks, while Westport-based Bridgewater Investment Corp. also appeared to have only an indirect exposure, reporting in November that it held roughly $3.5 million worth of shares in Citigroup.

The European debt problem is, however, already having a damping effect on the U.S. and the Connecticut economies, according to Deak.

"Every time something positive happens over there, there's a big move over here in the market," he said. "It shows there is more strength in the U.S. economy."

That the Dow Jones Industrial Average could surge 300 points in a day shows there are investors itching to make plays, but that it also swings so violently downward indicates people are ready to pull back in a moment's notice.

"That's fine if you're a long-term investor," Deak said of volatility. "You can take some confidence in the long-term in the U.S. economy in terms of stock market valuation, but if you're in the baby boom generation, about ready to retire, your heart is in your throat."

That's a problem for the economy as an overly cautious approach is keeping growth in check, he said. Deak said he expects 2012 economic activity abroad and at home to be about the same as this year.

The heads of the EU nations met and most agreed to create a stronger financial framework for the union, but LeBas said the accord doesn't address short-term debt issues.

The key concern over Europe is that rising borrowing costs for nations such as Italy, Spain, Greece and Ireland will spread the bunker-like mentality among banks to squeeze credit lines.

"That's happening already," LeBas said, pointing to a slowdown in lending. He said the larger issue for America is that this will ultimately kick off a recession.

Like other experts, he said the investment banks and larger international banks are better girded to face another credit crunch, but "there is some risk of a large scale liquidity lock up in Europe."

Janney Capital Markets sees continued strength in Treasuries and the higher rated municipal bonds, as well as nonfinancial corporate bonds issued by companies with little exposure to Europe.

LeBas would not say whether corporate bonds from Fairfield-based General Electric Co. or United Technologies Corp., of Hartford, would be a better play in the coming year because both generate significant revenue from European activity and are also facing spending cuts by the U.S. government.

Though he doesn't expect a major downturn in the global economy, he did say the chance of another global recession now stands at 50/50.